Two Fed Myths That Need Debunking

(By Brendan Smialowski -- Bloomberg News)

Now, to the question of whether the Fed can carry out its commitments, spoken and unspoken. Some say the Fed may run out of money as a result of the huge, high-dollar programs that it and the Treasury have launched -- or could end up launching -- to keep markets afloat.

The worry is that the Fed owns only about $800 billion in Treasury securities and that lending to investment banks, adding to the liquidity of world markets, and possibly helping arrange huge loans to Fannie Mae and Freddie Mac would consume more than $800 billion.

But that overlooks the Fed's amazing power to create as much money as it needs -- out of nothing, as it were.

Here's how it works. If an institution borrows, say, $50 billion from the Fed, the Fed can just post a $50 billion credit to that bank's account at the Fed, and the borrower can spend the balance on whatever it wants. It is indeed as if the Fed created cash out of nothing.

And if the Fed somehow needed more than its $800 billion of Treasury securities, it could buy them in the open market and deposit their payment in the seller's Fed account. That way, the Fed could lay its hands on however many Treasury securities it needed.

Yes, I'll grant that this sounds odd -- but if you ask a Fednik how this all works, he or she would tell you what I've just told you. Except it would be dressed up in fancier language, with all sorts of explanations of how the Fed can do all this and still carry out its monetary policy.

Why am I bothering you with this stuff in midsummer, a time when I'd rather be off drinking something cold than trying to deal with the Fed?

Because myths get in the way of understanding. And if there were ever a time when understanding the Fed's powers -- and limitations -- matters, that time is now.

Allan Sloan is Fortune magazine's senior editor at large. His e-mail address isasloan@fortunemail.com.